Skip to content

FRM Part II · FRM Exam Part II · Advances in Artificial Intelligence: Implications for Capital Markets Activities

A market-making desk replaces its rule-based quoting engine with a machine-learning model that adjusts bid-ask spreads in real time based on order flow, volatility and inventory. Which risk is the desk's risk manager MOST directly concerned about if many competing desks adopt similar models trained on similar data?

The main concern is correlated behavior. When competing market makers use similar AI models and data, they tend to react alike, widening spreads or withdrawing quotes together in stress, which amplifies liquidity shortfalls and market instability rather than reducing risk.

  1. ACorrelated quoting behavior that withdraws liquidity simultaneously in stressCorrect
  2. BReduced need for inventory limits because spreads adapt automatically
  3. CLower model risk because the models are widely used
  4. DElimination of adverse selection risk through faster quote updates

Explanation

If many firms use similar models and data, their responses to the same signals become correlated, so they may widen spreads or pull quotes together in stress, amplifying liquidity shortages. Wide adoption does not lower model risk and does not remove the need for inventory limits or adverse selection controls.

Did you get it right without looking?

One question tells you little. A timed set on Advances in Artificial Intelligence: Implications for Capital Markets Activities shows your real accuracy, how long you take and where you lose marks.

Practise Advances in Artificial Intelligence: Implications for Capital Markets ActivitiesFree diagnostic mock

More Advances in Artificial Intelligence: Implications for Capital Markets Activities questions